Chapter Study Outline

24.1 Search Activity

  • The two key ingredients to a nontrivial search are that wages or profits must be heterogeneous and that information must be imperfect.
  • If wages or profits are heterogeneous and information is imperfect, it is conceivable that the job acceptance probability will be strictly less than one since workers may turn down some job offers in the hope that a further search will uncover a more lucrative job offer.
    • In this context, search is an investment in information because active searchers forgo the benefits of current job matches in the hope that the costly acquisition of information will uncover better job matches.
  • In each period of the sequential-search model, unemployed workers must decide whether to search for work.
    • Workers who do not search remain unemployed.
    • If they do search, they incur a cost but will receive a job offer with some probability.
    • If a job offer is received, the workers must decide whether to accept it.
    • If workers accept the offer, they do not have time to continue with the search after they are employed.
    • There is no limit on the number of times an unemployed worker can search for a job, but search is costly and workers are impatient, so a worker would rather find a job sooner than later.
  • The reservation wage is the wage at which the worker is indifferent between stopping and continuing with the search efforts.
    • The reservation wage completely describes a worker’s optimal search behavior.
      • Workers who have in hand a wage offer that is less than the reservation wage will continue looking for another job.
      • Workers who have in hand a wage offer that exceeds their reservation wage will take the job.
    • The reservation wage is constant and thus is independent of the number of previous failed search attempts.
    • An increase in the reservation wage raises the steady-state unemployment rate and expected duration of unemployment.

24.2 Extensions of the Simple Search Model

  • A large body of empirical evidence indicates that the reservation wage declines with the length of time a worker has been unemployed.
  • There are four main hypotheses in the economics literature that attempt to explain the decline in the reservation wage as workers’ periods of unemployment grow longer.
    • Workers may face increasing search costs.
      • Unemployed workers may quickly run out of the financial resources necessary to maintain a tolerable standard of living while out of work.
      • There is often a strict limit on unemployment benefits.
    • Workers may be unsure about the exact form of the wage distribution.
      • Workers gain information about the wage distribution as they observe different wage offers.
    • At the inception of a job search process, workers may possess information about the potential locations of high-paying jobs but, if their initial efforts are unsuccessful, their search prospects become progressively bleaker,
    • During a lengthy unemployment spell, workers may lose human capital as their skills atrophy,
      • The relative human capital of unemployed workers might also decline because of the entry of young, better-trained workers.
  • On-the-job search is common in labor markets and is used by workers to find better jobs and improve the conditions of the jobs they already hold.
    • In an on-the-job search environment, workers set two reservation wages: one governs their behavior when they are unemployed and the other, their behavior when they have a job.

24.3 Wage Determination

  • One source of wage heterogeneity stems from differences among employers, which allows us to find a heterogeneous wage distribution in a labor market.
  • One of the simplest environments consistent with wage dispersion assumes the wage is competitively determined and marginal revenue product (MRP) differs across locations because of region-specific shocks.
  • The economy’s GDP equals the sum of all of the contributions from individual workers.
    • Each worker’s optimal search behavior results in the maximization of the economy’s GDP net total search costs.
    • The resulting outcome of individual optimal search behavior is Pareto efficient because the maximum is the best there is and so any other allocation of resources must lower overall well-being.
  • The Pareto efficiency of individual optimal search behavior implies that some positive equilibrium level of unemployment is also efficient
    • This equilibrium unemployment level reflects the proper allocation of resources to the acquisition of valuable information concerning the locations of high-quality job matches.
    • Policy actions intended to reduce the unemployment rate will be harmful.
    • Unemployment benefit payments will result in inefficiently high levels of unemployment because they drive a wedge between the true and perceived cost of job search.
  • The Diamond paradox shows us that if firms are homogeneous, it is optimal for every firm to set the same wage, which implies the wage distribution has no variation.
    • Before Diamond, economists had incorrectly modeled the search process—Diamond’s finding stunned economists because it appeared as if the optimal search behavior were inconsistent with any wage variation across firms.
    • Without any wage variation, there is no active search.
  • Burdett and Judd (1983) examined the case where some workers receive two job offers in a single period instead of only one job offer
    • This modification short-circuits the mechanism underlying the Diamond paradox,
    • Firms will offer heterogeneous wages because they worry about attracting workers since search is costly for them too,
  • The main result of the directed search model is that employers use their wage offers to influence the probability that at least one worker applies to them,
    • Wage dispersion occurs because a firm that offers a relatively high wage has a relatively high probability of attracting a job applicant although the profit is relatively low.
    • These conflicting forces can offset each other, implying that high-wage and low-wage firms earn the same expected profits, causing wage dispersion

24.4 Accessions: Search Methods

  • Workers use a wide variety of search methods to find work, such as newspapers, Internet message-boards, a network of friends, private job agencies , and unsolicited applications.
  • Workers are predicted to use the most cost-effective search methods available which means that different worker groups may rely on different job-search methods.
    • Different job-search methods may result in systematically different labor-market outcomes
  • Empirical work commonly finds that those workers who locate jobs using informal methods enjoy longer subsequent job tenure spells than those who use other methods.
  • The internet is becoming an increasingly important tool for job search.
    • The low cost of applying online leads to an excessive number of low-ability job applicants.
    • Employers are increasingly forced to use trolling methods that involve searching for workers who are not searching for work.